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Goldman Considers Settlement With SEC – SEC Moves For Criminal Probe

April 30th, 2010 Comments off

04.30.2010 original publish date
05.02.2010 update
02.13.2016 repaired/ replaced broken link, page format update

Goldman Considers Settlement With SEC – SEC Moves For Criminal Probe

original article written by Net Advisor


I have read the SEC complaint and the Goldman response posted here (near bottom page). I watched and carefully listened to the approximate 11 hours of testimony before Congress about the SEC-Goldman Sachs issue(s).

I took notes in short hand and recorded the hearings (via DVR) so I could replay some of the dialogs, and write about them here. Goldman’s stock has rebounded since the day of the Congressional hearing. Goldman wants to be done with this now, and the CEO goes public considering to settling the SEC’s case (Source: Reuters).

One day later after Goldman’s hint to offer a settlement, the SEC decides (based on my perception which is based on public actions): ‘OH, THEY (GS) wants to settle? They MUST be hiding something. Now we really got ’em. Let’s go and make it a criminal probe‘ (Source: Reuters, with emphasis).

We’ll, I’m not a lawyer, but was a securities compliance officer, did compliance for hedge funds, and have a lot of expertise in this field. I have worked with legal experts, including in securities law, both in-house and outside counsel, and even assisted federal law enforcement on a particular financial investigation.

I understood what Congress and the Goldman Reps were talking about at the hearing. They were mostly speaking in “industry language,” might as well be a foreign language than one knows nothing about. And based on my view, I think the SEC is really stretching it in this case. I do believe that Congress does not truly understand how financial markets work, let alone were they able to proper decipher what actually transpired verses pushing their political agenda. This is where I would take issue in law: Legal cases should not be settled based on politics (although they often do), the proper course to settle claims are in a court of law.

Shi**y Deal?
Again, there is a HUGE difference in trying to get the public upset by repeatedly using quotes of profanity by a leading Congressman Levin (D-Michigan), “this was one Shi**y deal,” (video: 4:35 min segment). There was no evidence proving some specific matter of breach of securities or other law. Everyone has opinions. Some are right some are not.

Recall about “junk bonds” or “high yield investments” as they are more commonly called now. These may be referred to as “shi**ty” but some investors will want to buy them because they are willing to accept high risk for high return. Modern Las Vegas was basically built on junk bonds (Sources:,,

By the way, I didn’t know you could say Shi**y on TV? Can I complain to the FCC for Congressional indecency? (sarcasm)

There are a lot of points I think I could argue that I don’t think Congress got a clear grasp, so I’m making some of them here.
1. Keep in mind that we are not talking about mom and pop investors. We are talking about TWO mega billion-dollar foreign banks that have high level of expertise in these CDO investments. This right here stops a big part of the case: SEC Rules 504, 505 and 506 regarding accredited investors and institutions. The investors meet the definition of “sophisticated” by being on top of the pyramid. There are not too many other people who have that level of expertise.

2. From what I gathered, the investors had every opportunity to look at the investment portfolio, and participated in the selection. No one in their right mind would put hundreds of millions of dollars into something without asking a few questions right? When I worked at a major Wall Street firm (not Goldman) you should have heard how many questions I would get when someone wanted to put $25 a month in a S&P 500 Index fund. Thus, if one was to plunk down $100+ million or $800 million, they might ask a question or two or have their in-house army of top ranked securities lawyers review the transactions before sending in the money.

3. Whether Paulson or whoever picked their nose or securities in the portfolio(s) doesn’t matter. John Paulson (not related to the previous Treasury Secretary Hank Paulson) was an unknown hedge fund manger back at the time in question (Source: NY Times). He was not the super star hedge fund king as we see him today.

4. Keep in mind that when you have what are called “structured products” (basically they are unique deals that are put together by 2 or more parties), you have to have TWO sides to make the deal work: There is a “long” person or entity (who thinks the portfolio value will increase, in value, thus will profit if that is the case. Then you have a “short” person or entity (who thinks the portfolio value will decrease in value, thus will profit if that is the case.

If you only have a long side, who is going to pay you if you are right? If you are only short, who is going to pay you? One side is going to pay off the other. Thus, you need both sides to agree on the deal (portfolio) -in writing- in order to have this deal done.

5. It is not illegal or unethical to speculate, change your mind, or trade in or out positions actively. I have bought things and sold them a minuet later because there was something I didn’t like, and changed my mind. Goldman and anyone else can do this with their investments, and you don’t have to get permission from mom, or anyone else to change you mind and take a different trading position or exit it.

6. Hindsight cannot be used to make investments better. Congress or anyone cannot use the benefit of hindsight and say it should have been done this way verses that way.

Quick poll to homeowners:

How many people in 2010 (assuming you still have a home) would like to sell your house in spring 2006?

Quick poll for stock investors:

How many would have liked to sell your “dot com” stocks in March of 2000?

No further questions, your Honor.

The point being, what Congress, the SEC, or other regulators can only do is determine what law, rule, or ethical violation may have occurred, if they occurred, and penalize for that breach of law or rule.

7. Goldman seemed to be facilitating what their client(s) wanted. One wanted long risk exposure in sub-prime assets, one wanted to take the opposite side of that risk (effectively go short).

8. Goldman, as market maker would normally move prices based on bids (sell or selling price) and ask (buy or offer price), and so would other competing market makers. I didn’t hear much whether other firms were making markets in these securities. If they were, the SEC case is weaker. You can’t blame, sue, or fine one market maker for posting a bid you don’t like. You place the bid with a different market maker if they offer a better price. This is how stocks and options work too.

9. To my compliance knowledge in understanding market making, the market maker does not have to show his/her book to anyone except Floor officials (on exchanges), and perhaps to regulators who have questions about a regulatory issue. It is like playing cards, you don’t show the players your hand. Everyone is bidding against each other, and the best offer prices are posted for people to buy and sell at any given moment. In private deals, this may be more difficult if there are no secondary markets.

This is a gray area which could help the SEC’s case, but it could be tough to prove, since we all know by now that real estate prices had been on the decline since about spring 2006 in most U.S. markets. Thus, if Goldman marked down the value of the portfolio and IF there were no other market markers, GS could argue such as the real estate market had correspondingly declined. Also keep in mind that Goldman was LONG the portfolio, and lost $90 million (Source: Reuters).

10. Despite Congress being upset for whatever reasons, it is not illegal or unethical to sell short. In fact independent studies have shown short selling is actually good for the markets as they provide increased liquidity, lower trading costs, and decreased risk to the markets. (Sources: ISLA International Securities Lending Association (UK), The Impact of Short Selling… (Hong Kong), Market Liquidity & Funding Liquidity, Princeton University and NYU, USA).

11. Conflicts. When I worked at a major Wall Street firm (again, it was not GS), my employer did provide and was in the business of investment banking, retail and proprietary trading. Again, there is nothing wrong nor unlawful about that. On the back of trade confirms, one will see how the brokerage firm acted on a trade. Typically the brokerage firm acted as “agent” or “principle.”

Agent: Firm has no interest in the trade. The firm simply executes the trade as an intermediary (-a middleman-) on behalf of the client.

Principle: Firm does have interest in the trade. The firm may be buying from you, or selling to you. They hold these securities in their dealer inventory. ALL major brokerage firms, investment banks etc., that have trading arms and engage in market making do this. It is as long as common practice since regulation began in the 1930’s.

This is no secret, and I saw this happen all the time. It is not illegal to act as agent or principle or both, just not on the same trade at the same time. Trades must be coded as if they were agent or principle for purposes of disclosure.

It is not unusual, illegal or unethical to have an underwriting arm, and a trading arm. They are required to work in separate departments and both are required to have independent and separate compliance oversight.

Rogue Trader?
I knew there was going to be more people involved than just Fabrice Tourre as I indicated in my 04-26-2010 article. I stated that there was going to be Tourre’s compliance officer/ supervisor involved, who we now know was Dan Sparks. Sparks was very evasive on some questions, but that does not make one guilty of anything. My view is Sparks just didn’t want to accidentally say the wrong word such as “investments” when he meant “investment,” then land himself in a lynch by the skilled lawyers in Congress.

SH**ty Deal?
Legal Speculation: Could some members at Goldman and maybe even Paulson have known that some of the deals where “sh**ty” in their eyes and that is why they went short.

I would argue that it was correct for the GS people to not speculate on things they did not know, nor were not involved in, nor to comment on what someone might have been thinking. These are all objectionable questions.

Congress attempted to seek many answers of things where they wanted the GS reps to speculate on, use hindsight for answers, provide answers to things that have more than one meaning, and guess what other people might have been thinking. Again, these kinds of arguments do not hold up in any court and would be objected by defense counsel as “speculation” in the case of speculation or “hearsay” in the case of what someone else may have told them. It is objectionable on the ground that it may take on more than one meaning is an ambiguous question. There were plenty of objectionable questions which may be used in the actual trial (Additional reference on legal objections).

According to the Congressional testimony by Fabrice “Fab” Tourre, he did not offer his personal opinion on the mortgage market. By not doing so, he now has a defense against being charged with “misleading investors” since he did not give an opinion of the market where he apparently had a financial interest in.

Not My Fault?
The clients (the German and Dutch banks) clearly invested the wrong way. I think it comes down to greed, and the “investors” (the two foreign banks) just called the real estate market wrong like millions of others. Perhaps like millions of others, they thought that the real estate market would keep going up, or at least for the foreseeable future. They were wrong.

The question is: Did Goldman have an obligation to say their views on the mortgage market to the clients on both sides of the deal? Clearly Paulson got it right for going short, and apparently without any help from Goldman.

Question: What if hedge fund Paulson & Co. was the one who went long and the two foreign banks went short on this deal? Would the SEC be taking on Goldman Sachs and defending a hedge fund that lost a billion, and the foreign banks made money?

The answer of course is no. Why? Because, under Regulation D (of the SEC Act 1933) the SEC generally sees hedge fund investors and hedge fund operators as “sophisticated” or “accredited investors” (Rule 501), thus deemed to have the financial capabilities, resources, and expertise to invest in complex strategies or even simple privately ran investment funds.

The SEC is more likely to protect the mom and pop mutual fund holder and go after bad brokers for fund switching A-shares, than defend a hedge fund.

Did Goldman have a Fiduciary Duty or Did They Just Act as Middleman?
Fabrice Tourre, who worked out of Goldman’s London’s office, stated during the Congressional hearing that (paraphrased slightly):

  • All clients were institutions, no retail clients – thus all were sophisticated clients.
  • There were only two clients who were in the deal in question.
  • There was nowhere in the (investment) docs (disclosures) that said Paulson would be the one who was short.
  • Tourre said it was assumed that someone would be short, and that could be Goldman Sachs and or another or other party or parties.
  • ACA picked the securities, not Paulson.
  • Paulson made suggestions to ACA of what securities he would like in the portfolio.
  • ACA rejected most securities Paulson picked, and accepted some of Paulson’s pics.
  • ACA was the one who made all the final decisions as to what was going to be in the Portfolio.

If this is true, it seems to be in proper securities compliance, at least on these said statements. One would need to read the actual fund disclosure docs and seek testimony from ACA, ABN Amro, IKB, and John Paulson to better confirm these statements or not.

Was it Tourre’s fiduciary duty to disclose his opinion of the mortgage market as he and a several others at Goldman saw it? Or was he just a middleman putting a deal together between two clients, who each of them took opposite sides of a trade? Both the German and Dutch bank clients and Paulson allegedly had access to look at all of the securities in the portfolio and thus can arguably conclude:

…all parties are considered world experts with investing in these kinds of securities, each firm has their own legal, compliance and due diligence departments. All parties agreed on the portfolio, signed off on the documents allowing the trade to begin.

Goldman Most Likely Did Not Deliberately Pull a “Fast One” on Its Big Bank Clients
Congress is acting as if GS pulled a fast one on a couple sophisticated international banks. I don’t think it would be in Goldman’s self-interest to mislead, or try and rip off any investor, foreign or domestic for any amount of money as the firm has a 141 year history of making money. And the reputation damage if such were proven true, would pretty much end Goldman Sachs as a firm, just like the bond scandal did at Solomon Brothers, and the junk bond scandal ended Drexel Burnham Lambet in 1990.

12. Senator Tom Coburn (R) – (Oklahoma) stated that the reason he was late to the Goldman hearing was because he was working on a much bigger case than the one we are talking about now – Goldman. The Senator gave no further comment or explanation, and did not look at the camera when making these comments. Was this the criminal complaint now being probed, or is there another shoe to drop?

Aren’t We Missing Something From This Equation?
13. What I think Congress is missing is how did these mortgage securities originate? Did Goldman Sachs issue sub-prime mortgage loans to individuals? No, Goldman was not a chartered bank at the time and did not issue mortgage loans.

Banks issued the mortgages and sold them to Goldman and other firms who repackaged the securities into a portfolio of mortgages where (institutional) investors could go long or short the portfolio based on client’s views of the housing market. Banks also had the ability to underwrite securities and sell them into the market place. By doing this banks would lay off the risk of these loans. Thus banks could just issue those no verification, no money down just sign here loans (“stated income”) and then transfer the risk to the market place. But are any of the banks who did not go under being targeted? No. Why? Good question.

Trading in Fast Markets
14. Something else I don’t know if Congress seems to fully understand. When you have an issue (securities, stocks, etc) that is trading in the open market, called the Secondary Market, firms who make a market in those securities (otherwise they make offers to buy from you at a price and sell to you at another price) called market makers, they will buy and sell frequently and use strategies going long and short so they don’t overexpose themselves with too much risk. This is what I see Goldman did and all firms do this and it is perfectly legal and it’s how markets and market makers work. Dan Sparks, the former head of the Mortgage Department at Goldman Sachs (2006-2008) stated this in so many words in his testimony before Congress on 04-27-2010.

I have done the same thing but just in slightly lessor dollars. This is sometimes called, “trading around a position,” also various other kinds of hedging strategies can also be used to protect a position to reduce overall risk, volatility, or just reduce potential loss.

One of the things I got from Sparks testimony was that the sub-prime markets were moving so quickly that it may have been difficult to calculate or assess the risks in the portfolio, or determine the instant or approximate value of what are often not very liquid positions such as Mortgage Backed Securities (MBS), Collateralized Debt Obligations (CDO) or Synthetic CDOs, and the alike.

Sparks stated that Goldman was losing money in the fall of 2006 being long the mortgage market.

During volatile, illiquid, and or fast moving markets, price discovery – trying to determine the value of say a stock, bond, other security, including but not limited to CDO’s can be difficult. As buyers and or sellers rush in and out of the market with millions to billions of dollars, and this could be difficult for market makers to keep up with this level of trading activity, let alone a panic. One can also make or lose money very quickly, especially if they are leveraged. (Example : Lehman Brothers)

Fast markets didn’t just happen in sub-prime or to Goldman, they have happened throughout market history, and from time to time in periods of uncertainty. Although Dan Sparks didn’t articulate himself to this detail, but his testimony to me suggests this could have been part of what actually occurred. Thus Goldman could not keep accurate track of prices during times of fast moving markets, especially in complicated securities.

The AIG – Goldman – U.S. Government Connection

15. Permanent Subcommittee Chairman Carl Levin (D-Michigan) hammered Goldman Sachs CEO, Lloyd Blankfein especially over AIG, and this is why according to Blankfein’s testimony:

  • AIG owed Goldman Sachs approximately $2.5 Billion.
  • Goldman Sachs took out an insurance policy (called a credit default swap or “CDS”), that basically says if AIG defaults (including goes bankrupt) on the $2.5 Billion AIG owes Goldman, this other insurance company (not stated who) would pay Goldman the $2.5 Billion under that insurance policy.
  • Goldman pays the insurance premium(s) to be able to own this insurance policy.
  • AIG received at that time an initial $85 Billion cash infusion from the U.S. Government.
  • Here is the part that makes Senator Levin livid: According to Blankfein’s testimony, because the U.S. government choose to intervene (bailed out on AIGs insurance policy defaults) to prevent AIG from going bankrupt, AIG was legally obligated to pay the $2.5 Billion insurance policy they owed Goldman. Thus, Levin claims that Goldman got ‘$2.5 Billion of tax payer AIG bailout’ money.
  • In fairness, AIG had billions in assets, they were just short of cash, and really had not kept money in reserves to pay out big policies. Whether the money was from TARP, the FED, or otherwise, AIG had the legal liability to pay Goldman. So it’s really a form of semantics.
  • I might speculate and argue what upsets some people in Congress the most, is no matter how you slice it, Goldman covered their you know what so they would collect on the insurance policy they took out and paid for. Thus Goldman wins in any scenario; and that my friends is why Goldman makes billions each year.

If the U.S. government allowed AIG to fail, then another insurance company would have paid Goldman for AIG’s default and NOT, the U.S. government. Thus, because the government interfered with AIG, they obligated themselves to write up to $170 billion dollars in checks to many people, not just Goldman. Three foreign banks, Societe Generale, Deutsche Bank and Barclays combined got more than double what GS received as a result of government bailouts of AIG.

— Source: CNN

No one is discussing or investigating foreign banks. Congress doesn’t seem to be upset that tax payers are bailing out foreign banks with billions of U.S. tax dollars. We’re only upset because Goldman made money and allegedly “mislead” two foreign banks. Something about this congressional investigation just does not seem right.

Main Street also got a boost. The U.S. tax payer via the AIG-Government bailout was also obligated to pay $12 Billion to municipalities (states, counties, etc).

What Happened in More Simple Terms:

  • You loan $100 to a friend (#1).
  • You think friend (#1) will pay you back.
  • Another friend (#2) of yours says hey, if he (friend #1) doesn’t pay you back, I will pay you back. And for me giving you this guarantee, I want $10.00 upfront, and I (friend #2) will guarantee payment to you.
  • You give friend (#2) $10.00 cash.
  • Now you have 2 people you could collect $100.00 from. Friend (#1) who directly owes you $100; and friend (#2) who is guaranteeing you repayment if (friend #1) defaults (i.e. doesn’t pay you back).
  • Friend #2 really just issued you a credit default swap – a guarantee of payment, again in the event friend #1 defaults payment (doesn’t pay you back, goes bankrupt, etc).
  • To guarantee that you get paid, you took out a $100 insurance policy from friend (#2). The insurance policy cost you $10.00.
  • You will get your $100.00 back. But you will really end up with $90.00 back if friend (#2) ends up paying you. ($100 insurance policy less $10.00 cost of the policy = $90.00 net back to you). $90 is better than $0.00 right? That is why credit default swaps are issued. People are willing to pay an insurance premium to guarantee that they will get money that is legally owed to them in case the other party defaults and thus can’t pay.
  • Thus, because AIG (friend#1) owed Goldman money and AIG did not default, AIG had to pay. If AIG went bankrupt, another insurance company (friend #2) would have guaranteed AIG’s payment to Goldman. Since the U.S. government interfered and took over AIG, the U.S. government (tax payer) took over the liabilities of AIG and thus, had to pay.

Here is the problem that contributed to nearly collapse the world’s financial system:
AIG had allegedly issued $441 Billion worth of credit default swaps and kept no cash reserves to payout any insurance policies if there were any claims made by policy holders. Ooops.

So when say Lehman Brothers failed (defaulted/ went bankrupt) (friend #1), all the people who previously went to the world’s biggest insurance company, AIG (friend #2), said, ok, Lehman (my friend #1) flaked, can’t pay, so I am here to collect from you AIG – (friend #2) because you guaranteed me that if the other guy (Lehman – friend #1) doesn’t pay, you will pay. So what happens if friend #2 has no money to pay you. When we are talking billions of dollars, you take a total loss on the original money you loaned out, plus you lose the insurance payment(s) you made to friend #2. Thus you actually lose more money than you did in the first place. Result: Both of you can go bankrupt.

As noted, Senator Levin was very bothered by Goldman getting $2.5 Billion it was legally due from AIG. Again, had the US government not bailed out AIG, Goldman would have got the money from another insurance company. Levin continued to say Goldman got $2.5 Billion of tax payer money anyway. There is nothing illegal, or unethical about this. It was a legal contract, and whether we like it or not, the government allowed AIG to stay in business, and thus it had to pay all of its obligations, including funds that went to foreign banks!

AIG is still under SEC investigation. Why Congress isn’t hanging these guys at AIG out to dry for clearly in my view, AIG breached every fiduciary obligation ever written is beyond me. Yet, perhaps a little oversimplification, but basically Congress wants to go after Goldman because they made money, when others were losing money.

Goldman Settlement?
16. Goldman Sachs is thinking that they want to be done with this now, and the CEO goes public considering to settle with the SEC (Source: Reuters). It’s probably a good move. I think the SEC case is weak. Goldman is apparently willing to pay what might be large fines and the SEC could say they won, with Goldman admitting no wrong doing. Then the SEC could go after the real and more obvious culprits of the crisis.

But could it be ego or real new evidence that the SEC is now upping the ante to make Goldman a criminal probe? This will all come out over the next few days, weeks or so. The downside is this can drag the entire financial sector down again, and is this what the government really wants to do?

Who Really Has a Conflict of Interest?
17. After closely following and collecting literately 1000’s of articles since 2007 to date, I think the SEC would have a much easier and stronger case against AIG, than they would verses Goldman Sachs. The difference in my assessment is the government, the FED, the Treasury, collectively owns 80% of AIG, and 0.00% of Goldman Sachs. AIG has no money to pay fines, especially since the government dumped $85 billion+ in AIG to keep them afloat. If the government sued AIG, they would just be paying the government back its own money that the government borrowed to finance the bailout in the first place. On the other hand, Goldman has billions in cash it could pay the government. So whose deep pocket do you go to collect from? Your own money, or some other person’s money? Your witness.


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